Estimated Net Equity % (Organizational Equity) is one of the financial ratios that McDonald’s considers when evaluating financial health and viability. Net Equity should be at least 25%, which matches the initial equity injection required on existing restaurant purchases.
The value of the business, minus debt on the business, divided by the value of the business is how Net Equity % is calculated. A simple approach is used to estimate the value of a business.
The value of a business equals Cash Flow before Debt Service, G&A and Draw less standard G&A, which is $35,000 for traditional restaurants and $10,000 for satellites, less reinvestment, multiplied by a Cash Flow multiple of 4.5.
As you know, this is not the best way to value restaurants. If the equity percentage is calculated to be less than 25% using this formula, then a more precise method of valuation using a discounted cash flow method (with actual reinvestment) should be used to more accurately determine the value of the business.
Net Debt measures an Owner Operator’s consolidated leverage or outside debt position. Building and Site Debt is excluded from this calculation so that comparability is maintained. Net Debt is computed by taking Total Current Liabilities plus Total Long-Term Liabilities, minus Note Payable Stockholder, minus Current Assets. Both debt and cash flow will be appropriately adjusted for all NEP restaurants.
Here are some examples:
| Current Assets | $150,000 |
| Current Liabilities | $200,000 |
| Long-Term Debt | $175,000 |
| N/P Shareholder | $ 50,000 |
Net Debt Calculation:
| $200,000 | Current Liabilities |
| + $175,000 | Long-Term Debt |
| − $150,000 | Current Assets |
| − $ 50,000 | N/P Shareholder |
| = $175,000 | Net Debt $ |
| Cash Flow before debt service, G&A and Draw: | $250,000 |
| Traditional Restaurant G&A: | $ 35,000 |
| Reinvestment Needed: | $ 50,000 |
| Net Debt (from above): | $175,000 |
| Cash Flow multiplier: | 4.5 |
Estimated Net Equity $ Calculation:
| $250,000 | Cash Flow |
| − $ 35,000 | G&A |
| = $215,000 | |
| x 4.5 | Cash Flow multiplier |
| = $967,500 | |
| − $ 50,000 | Reinvestment |
| = $917,500 | Estimated Restaurant Value |
| − $ 175,000 | Net Debt |
| = $742,500 | Estimated Net Equity $ |
| Estimated Restaurant Value (from above): | $917,500 |
| Estimated Net Equity $ (from above): | $742,500 |
Estimated Net Equity % Calculated:
| $742,500 | Estimated Net Equity $ | |
| divided by | $917,500 | Estimated Restaurant Value |
| equals | 80.92 | Estimated Net Equity % |
In this example the Estimated Net Equity % of 80.92% is far in excess of McDonald’s required minimum of 25%.
Increases in SOI, pre-debt cash flow and profitability in your restaurants will have a positive effect on your Net Equity percentage. Limits to required reinvestment and decreases in overall debt will also positively affect your Net Equity percentage. Conversely, decreases in SOI, pre-debt cash flow and profitability in your restaurants will have a negative effect on the Net Equity percentage as will increases in required reinvestment and overall debt.